Hear that? It may be the rumblings of a beginning to an economic recovery. Many are skeptical, though, that we’ll see a quick bounce-back. Instead, experts predict a gradual return to a healthy economy.
Even while the larger economic picture starts to thaw, your company likely still faces economic pressures. If those pressures require cuts in your benefits, you may wonder about the legal implications of benefit cuts. You wouldn’t be the first to ask; Lisa Van Fleet, a partner with Bryan Cave LLP, hears the question all the time. She spoke to BLR recently about the ways some companies are reducing benefits costs and some of the potential traps waiting when they do.
Can You Cut Your Employer Match?
The most common inquiry during the last quarter of 2008 and the first quarter of 2009 was whether companies could eliminate their employer matching contribution, Van Fleet reports. The answer is not a simple yes or no. Instead, it depends on the type of 401(k) plan you sponsor. “There is kind of a staircase of obligations depending on which type of plan you have, even though they’re all 401(k) plans. Is the match discretionary, mandatory, or safe harbor? The level of employer obligation increases with each different type of plan.”
For plans with a discretionary match, Van Fleet says eliminating the match is not complicated; you are free to do so at any time. However, legal obligation and employee expectations may collide if employees have come to expect a match.
“Many employers have a practice of making a match every year,” Van Fleet says. “So despite the fact that no change would be required in the plan document, companies should do an employee communication about the change. No matter what the legal obligations, they should still let people know about the change in advance.”
Plans with a mandatory match should be amended to eliminate it or make it discretionary, and it would be considerate to let participants know in advance. Safe harbor plans can also be amended to eliminate the match. In a safe harbor plan, sponsors are not subject to certain testing requirements, because they have already committed to fully vesting their employer contributions immediately when they are made. The contributions may be matching contributions for those participants who defer part of their pay into the plan, or they may be contributions on behalf of all eligible employees, without regard to whether they defer part of their pay to the plan. In order to eliminate the employer match in a safe harbor plan, Van Fleet says more is required than a plan amendment.
“You have to give an advance 30-day notice before you can eliminate the match from a safe harbor plan. That can be tricky for employers who decided to save some money by quickly eliminating the match. They may have made up their minds quickly, but they can’t act immediately. They have to give that 30-day advance notice.” The Internal Revenue Service has also recently offered proposed regulations allowing employers who sponsor safe-harbor plans to suspend or reduce their nonelective contributions to the plan. The proposed regulations would impact business undergoing substantial hardship.
Van Fleet also makes her 401(k) clients aware of the implications of eliminating their employer matching contribution when the plan uses the prior year testing method. “If you eliminate a match and you’ve been using the prior year testing method, now all of a sudden you have a year where there is no match for those not highly compensated. Let’s say you decide things are getting better so you can re-implement the match. If you were using prior year testing, you won’t be able to make a match for the highly compensated employees for a year. You could switch to the current year method, but once you switch you’re stuck with it for a period of time.
“Be aware that if you’re going to eliminate a non-safe harbor match, it could restrict your ability to provide a match to the highly compensated employees in the subsequent year if you’re using prior year testing methodology.”
When You Must Lay Off Employees
Bryan Cave is also fielding many calls about how to structure a reduction-in-force, says Van Fleet. “Once companies decide which direction they want to take—an early retirement incentive or just a mass layoff—then they have to decide what their package is going to be. Usually these kinds of severance arrangements are outside the scope of their standard severance plan, because this is a one-time program that they create special benefits for.
“Before the new federal COBRA subsidy, they typically included some level of COBRA assistance, but of course, that’s no longer necessary. Now, mid-stream, employers are revising those COBRA-subsidy programs because it’s not a good use of their dollars if they can have the federal government pay for those subsidies. Instead, they are rechanneling those dollars in another direction, whether it’s an enhanced payout on severance, or some other benefit. Typically, though, we’re seeing enhanced severance payouts, like additional lump sum amounts.
“The immediate concern of many of our clients is that their employees who have not been let go remain satisfied and comfortable that they’re not next on the chopping block,” Van Fleet continues. “You can’t guarantee that, especially when some people think that things will continue to go south before they head north. Companies want to know how they can reach out to employees who are left, to let them know they are valued and that the company is working to preserve their jobs, and that the company cares about them and their careers. With respect to the group that’s being terminated, they care about treating them humanely.
“I may be biased because I represent employers, but what I hear them saying is that they feel they have an obligation, a commitment, to these people that they can’t fulfill. So they’re just trying to make it as painless as possible. If they have people who are on the cusp of leaving, like someone who is close to early retirement age and would like to retire, but is only age 52, they want to take advantage of that.”
Defined Benefit Plans Take Triple Hit
“We’re also getting questions about pension plans, but it doesn’t impact as many employers,” Van Fleet says. “They have a double whammy. Not only do they not have the cash to make contributions to the defined benefit plan, and even frozen plans may still have funding obligations, but now they’ve just lost half their assets like everyone else. You could even call it a triple whammy, with the Pension Protection Act of 2006, which imposes higher funding obligations on plan sponsors. It was going to be bad enough with the stricter funding standards, but add to that the market losses and the lack of cash flow, and there are some real compliance issues.”
“These are the strategies that leap to an employer’s mind as natural solutions to a cash-flow problem,” Van Fleet concludes. “But before they act on these ideas, they need to understand how they can implement the strategies in compliance with existing laws and notice requirements. Make sure you know the obligations and ramifications associated with the action before you commit to it.” As you might expect, Van Fleet advises that you consult with plan counsel before adopting your cutting strategies—always a wise idea.